––– a weblog focusing on fixed income financial markets, and disconnects within them

Wednesday, June 21, 2017

The Electronification of Consumer Pricing

Would it be interesting if we told you that owners of Apple products often pay more for the same product when purchasing it online? What about if we told you that airlines might jack up the price of their products based on your level of enthusiasm for buying a ticket?

A version of this is occurring in the United States. We're going to explain some of the beauty of this process, from an efficient markets perspective, but we'll also try to home in on the ways in which it can be jarring, if you're the user/customer/client/consumer, that is.

Briefly, companies like Expedia.com, Hotels.com, or Home Depot or Walmart might "collect" data from you or your computer when you search for a product or a flight or a hotel -- or "make a request." A user's request often brings with it information such as the user's browser, operating system, IP address and other information being maintained in what are called tracking cookies. Of course, if you're logged in, the company may already have some of this information about you (your purchase preferences) or other information it cannot get via the cookies or IP address.

Based on your information, companies often personalize their results for you.

There are at least two forms. They might steer you, say, to relatively more expensive hotels if you're using an Apple product, as they might infer that you're relatively wealthy. Or they might customize the pricing of the product based on your perceived level of interest. A person who regularly flies home for Christmas may be a prime suspect for an increased price, or if a prospective buyer has already checked on the price of a flight twice previously, it might indicate that he's relatively more desperate to buy a specific ticket.

Image licensed by PF2 Securities from Condé Nast (New Yorker)

Different from typical supply and demand economics, the new age presents a form of dynamic pricing that measures a person's capacity and motivation for purchasing.

Here, it's not just a demand of one unit or one ticket: it's a relatively enthusiastic or relatively needy and able buyer, as opposed to a marginal buyer, who may go elsewhere if the price is too costly.

From a company's perspective, they are using your information to price their product accordingly for you, and if they optimize this process, they can make a lot more money than store sales allow, with store sales typically requiring them to fix a single price per good.

One way to think of dynamic pricing is that it adjusts to you. If you're regularly checking the price, it may just go up because you're checking it.

This seems in many ways to perfectly capture the idea of capitalism. It may also be agreeable to consumers in perfectly competitive markets. But absent perfect competition (e.g., the presence of some monopolies) or when market players dynamically calibrate their models in a way that they seem to work in concert (even if it's not collusion), consumer-customers might feel they are being squeezed.

This graphic shows the results of ticket searches on Kayak's website and Google Flights on different days.
Several airlines are perfectly matching one another, to the dollar, on certain tickets (for better or worse).

Some jurisdictions take issue with price customization, which is often called price discrimination, although that term brings with it negative connotations. While many jurisdictions have (or should have) legal concerns if price discrimination is gender or race based, some already have difficulties if the pricing is not objectively justifiable relative to the seller, for example, based on the specifics of the order (e.g., company's cost of producing it for a specific user, delivery location or quantity). But many jurisdictions feel it is in the seller's power to adjust the price as he or she see fits, outside of, say, race and gender-based discriminatory issues.

The problem is magnified in the following example:

Suppose you want to buy a rare and expensive item -- maybe an sought-after watch or antique furniture or a Stradivarius -- and you call to ascertain its price and availability. You drive 200 miles to buy it and, on arriving at the destination, the seller tells you that, since you asked after it, he realized that demand was high and he lifted the price in the intervening hours. As a prospective purchaser, you might rightly feel that your eagerness to purchase the product was used against you (and you are now committed to purchasing at the newly higher price, given you have just driven 200 miles).

You were, in concept, taken advantage of. But legally, is there anything wrong with that? This is a question for the new age of online, inter-day price re-calibration. Companies can publicly access or otherwise purchase information about your spending habits, even the price you paid for your home, and this data may help them fit their pricing algorithm, uniquely tailored for you. This is happening. This is the new world of e-commerce and we should try to understand and discuss the issues involved. We welcome your feedback.

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For further reading on dynamic pricing on e-commerce websites, see here.

For issues on pricing/valuation concerns in the financial markets, click here.

Great topic, Marc! I am suspicious (and fairly sure) Amazon does this to me. The algo knows I've read the first X books in the Nero Wolfe series, so it shows me (ridiculous) full price for the remaining books. Yet I'm offered a discount for titles of an author I've never tried. I like the algo in the latter circumstance but not the former! My view is "yes, it should be legal" but also that consumers won't like it when they appreciate what's happening. The consumer backlash could well discourage the practice (when it's visible). An example is a store that raises its prices for bottled water and flashlights when there's a run due to emergency events such as hurricanes. The store may legitimately argue that it rations the supply of critical items by raising the price, but customers see it merely as price-gouging. Thus, stores now tend to keep the same price but limit what each customer can buy.